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Less brotherly love

Shortly before Jia Yueting’s empire started to unravel last year, the founder and largest shareholder of technology and media group LeEco pledged Rmb39 billion ($6 billion) of shares in the group’s Shenzhen-listed unit, Leshi Internet Information, to 13 different financial institutions.

Jia used the money to fund his aggressive expansion into areas like electric cars and smartphones.

The plan turned out to be a disaster for the company and by January this year Leshi had seen more than Rmb30 billion of its market value wiped out. Jia, whose shares have since been seized by the courts, has taken refuge in California. More recently the tycoon was put on a credit blacklist by the authorities, which blocks him from borrowing from banks or even buying railway tickets (should he return to China).

Since then any news of fundraisings with a large-scale pledge of shares has made investors nervous. In early June, Wang Zhonglei and Wang Zhongjun, major shareholders of Huayi Brothers, pledged most of their stock rights. According to the filing with the Shenzhen exchange where the media firm is listed, the Wang brothers offered a total of about 25% out of the 28.2% stake they owned as of March 31. But the timing of the share-pledge couldn’t have been worse, just a few days beforehand a tax probe was triggered by allegations that actress Fan Bingbing was underreporting the income for her work in upcoming Huayi Brothers production Cell Phone 2 (see WiC412). After the news, investors were worried that the two brothers were trying to cash out, sending the company’s shares tumbling. On June 4, the Beijing-based studio plunged by the 10% daily limit, incinerating Rmb2.3 billion of market value in a single day. It fell further in the following days, losing Rmb4.4 billion in market capitalisation over a two-week period.

Is that an overreaction? Entertainment Capital seems to think so. “The painful lesson from Jia Yueting and LeEco, and what happened to large share-pledges and their explosive outcomes at the beginning of the year, [Huishan Dairy had a similar problem] has remained very vivid in investor minds. So the market now has a reflex reaction to equating large share pledges with a major crisis,” the entertainment blog observed.

Using shares as loan collateral is more common among small and mid-cap companies where controlling shareholders own large stakes. They sometimes reinvest the proceeds in other projects or buy additional shares on the secondary market to boost the share price. According to Huayi Brothers, the loans raised against the share-pledge were for new investment projects. The company said that deploying the shares as collateral “did not indicate that the founders were pessimistic about the future of Huayi” but that they wanted the capital to “meet personal financing needs, mainly for use in other projects and equity investment”.

To stop the landslide of negative press, Huayi also threatened legal action against “malicious rumourmongers,” claiming speculation surrounding the two brothers as libellous, says Tencent News, a portal.

Still, such a large-scale share pledge has raised concerns that Huayi might have a liquidity problem, Caixin warns. In recent years, a large portion of the studio’s revenue has been boosted by one-off investments outside filmmaking, adds Huxiu. The portal points out that when non-recurring income is deducted, the studio had a net loss of Rmb40.2 million in 2016. Similarly, in the first three quarters of 2017, investment income contributed 83% – or Rmb687 million – of its earnings before taxes. That is largely a result of selling down its stake in Yinhan Games, a mobile game developer.

“Since a few years ago, Huayi Brothers has largely filled its annual report with strong performance from technology stocks. However, investment is not its core business. As a listed company, it is still necessary to focus on the development of its core business [filmmaking] and find ways to improve on that.”

In the meantime the speculation about Huayi’s prospects shows no sign of abating. Just a week ago the studio made a big splash at the Shanghai International Film Festival, unveiling an ambitious slate of productions for 2018 and 2019. However, Variety, an industry magazine, noted that no major government figures were present at the event, which it interpreted as ominous.

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